Economists differ about the number of central problems or functions of an economy. In the opinion of Prof. P. A. Samuelsson there are three central problems of an economy.
In the opinion of Stigler these are four in number and to Left with these are five in number. We shall discuss here the following three central problems of an economy:
1. What to produce,
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2. For whom to produce.
3. How to produce,
1. What to produce:
Resources are scare in relation to wants. Everything cannot be produced for everyone. More of one goods means less of other.
Therefore, an economy will have to choose that which wants be satisfied and which one it should for ego. This problem has to aspects :
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(a) What goods and services be produced, i.e., which consumer goods and capital goods be produced.
The economy has to choose among hundreds of consumer goods themselves and decide about allocation of resources between chosen goods.
Among consumer goods, choice has to be made between necessaries and luxuries. Similarly the choice is to be made between different producer goods.
The decision about allocation of resources between consumer goods and capital goods is of crucial importance from the viewpoint of economic development,
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(b) The economy has to decide not only which consumer goods and producer goods be produced but it has also to decide the specific quantities of each capital goods and consumer goods.
The economy cannot produce unlimited quantities of goods chosen to be produced. Therefore, an economy will have to decide how much bread, clothes, automobiles, shoes, machines, cement, etc. be produced.
This problem can be illustrated with the help of production possibility curve (PPC). A production possibility curve represents the various combinations of two goods which can be produced with an economy’s given resources and technique, assuming that all resources are optimally utilized.
In the above fig (a) PP is the production possibility curve of an economy. If the economy chooses a combination A, then it can produce OM quantity of capital goods and OQ1 quantity of consumer goods.
On the other hand if it decides to produce more of consumer goods, then it will be able to produce less of capital goods.
It is clean from combination B that if the economy decides to produce OQ2, quantity of consumer goods, then it will produce less of capital goods, i.e. ON quantity of capital goods method.
It is in the interest of the economy that those methods of production be used that make greater use of relatively abundant factors and economies the use of those factors which are relatively scarce.
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2. For whom to produce:
Every economy has to decide-how to distribute the production among different individuals and households.
The problem is who should get how much from national output. The productive resources and the resulting output being scarce, an economy will have to decide how the national output be distributed.
Who should get how much depends upon who possesses the purchasing power. The purchasing power depends upon the ownership of factors production and prices or rewards of factors of production.
Thus the real problem is how the rewards of different factors is to be determined. Once the reward of different factors in the NO is determined, it would become easy for the economy to decide for whom it is producing. The distribution of national output is the burning question in each economy.
It is clear from the above analysis that the main functions of an economy are to decide what, how and for whom to produce.
What to produce also involves. What provision be made for economic growth so that an economy may be in a position to satisfy more and more wants of the people in future.
The growth and prosperity of an economy depends on how efficiently it performs its functions or solves its central problems.
3. How to produce:
The scarcity of resources also compels an economy to decide how different goods be produced. This problem is concerned with the choice of the combination of factor inputs or the choice of technique of production and efficient use of resources.
It means that in what proportion or combination the factors of production be used to produce a goods at least cost combination.
Different techniques use labour and capital in different proportion. For example clothes can be produced with either handlooms or power loom or automatic looms.
Production with handlooms requires use of more labour and less of capital, while production of clothes with automatic looms requires more capital in relation to labour.
Use of handloom, is a labour intensive technique and use of automatic looms is a capital intensive technique of production.
Thus, the problem is of choosing between labour intensive technique and capital intensive technique of production.
Efficient technique of production is that which minimize the cost of production. The choice between different techniques of production depends on the availability of different factors of production, their relative prices and available technical know-how or technical expertise.
The scarcity of resources compels an economy that the goods should be produced most efficiently and economically.